Above normal return from gold not sustainable in the long term

An official study issued on Friday by the Reserve Bank of India (RBI), while decrying citizens' preference for gold as a saving, also makes clear why it makes sense for so many. The price of gold carries an uncertainty premium arising from risk aversion among investors in recent years. This has caused an above-normal return, not sustainable in the long term, says the RBI's Financial Stability Report.

Since Indian households hold a significant quantity of gold, they face the risk of a correction in its price, it warns. But on a year-on-year basis, agreed the report, gold offered the highest return among asset classes for a majority of the years after the global financial crisis.

Also, it noted: "Gold is easily accessible. It is a store of value, has no credit risk and is relatively liquid, thereby incentivising many households to buy gold."

The fall in financial savings, says the report, has implications for capital formation, as it channelises savings towards the "unproductive holding" of gold. If gold supplants financial savings as a primary form of savings, it has stability implications for the financial sector, it warns.

According to RBI, financial savings of the household sector declined to a two-decade low of 7.8 per cent of gross domestic product (GDP) in 2011-12, from 9.3 per cent in 2010-11 and 12.2 per cent in 2009-10.

This has happened despite nominal GDP (at market prices) rising by more than 15 per cent during the period. Households have been shifting away from financial assets into physical assets and valuables such as gold, as evidenced by increase in gold import, the report says.

It also points to a number of reasons for the fall in financial savings. "Inflation has been high during the past few years. Consequently, the real return on financial assets has been very low," it noted.

Households seem to have shifted their savings from assets earning low real rates to assets perceived as inflation-proof.

There has, thus, been a substitution towards non-financial assets like real estate and gold, the real returns on which have been relatively high, it said. In addition to the higher real returns on gold and residential housing, other factors could be impacting the fall in financial savings and an increase in physical savings and valuables in household savings, the report said.

"Relatively easy availability of bank credit for housing and the commensurate rapid increase in bank credit during the early and mid 2000s has provided a fillip to house prices," it said.